Investors Yawn As Amazon and Facebook Beat and Raise

Amazon and Facebook -- I have no financial interest in their securities -- reported expectations-beating revenue and profit growth and boosted their forecasts.

Their stock prices should have exploded -- after all, when these two companies blew through first quarter earnings expectations in the first quarter, their shares popped 12%.

So why did investors yawn this time? I don't know -- but it looks to me like that could be a gift to investors.

Before getting into that, let's look at what Amazon and Facebook reported.

On July 28, Amazon beat on revenues and profits and raised guidance. Amazon reported a profit of $857 million -- or $1.78 per share -- EPS beat analysts' expectations by 67 cents a share according to Thomson Reuters I/B/E/S.

Amazon Web Services revenue spiked 58.2% to $2.89 billion -- beating the average estimate of $2.83 billion. AWS generated 9.5% of Amazon's revenue but 56% of its operating income, according to U.S. News and World Report.

What's more, over half of U.S. households are members of Amazon Prime -- the $99 annual fee service that gives consumers same-day-delivery among other perks, according to U.S. News and World Report.

Amazon's revenue guidance for the current quarter -- net sales of between $31.0 billion and $33.5 billion -- exceeded the Wall Street average of $31.6 billion, according to Thomson Reuters I/B/E/S.

On July 27, Facebook accomplished a similar feat. Its sales rose 59% to $6.44 billion — 7% above expectations according to S&P Global Market Intelligence; profit for the second quarter nearly tripled to $2.06 billion; and its EPS before items nearly doubled to 97 cents — 18% above expectations.

Yet investors gave Facebook the Bronx cheer -- the stock rose a mere 2% from $122 the day before it announced earnings to $124.94 in July 29 pre-market trade. When Facebook reported similarly great earnings in April, its shares soared 12% in pre-market trading.

For those looking for a reason not to like these stocks, there is supporting evidence.

Facebook said it was concerned about over-saturating users with advertising. CEO Mark Zuckerberg and chief financial officer Dave Wehner made clear that they did not want the ad load to overwhelm users -- including resisting the urge to create video pre-rolls.

Wehner that this could lead to lower successive growth rates in ad revenue starting in 2017, noted CNBC.

But does that mean Facebook's growth is irreparably capped? I interpret this as Facebook warning investors that it is balancing the urge to boost revenues against the risk that overwhelming users with too much advertising would make them quit the social network -- or spend less time there.

And Amazon suggested that it will keep on investing in growth. To that end, it told investors that it would report "low operating income for the current quarter of $50 million to $650 million," according to Reuters.

Another factor that might worry investors is that Amazon's fulfillment expense rose about 35% to $3.9 billion in the June-ending quarter.

Finally, Amazon trades a Price/Earnings ratio of 187.

What investors may be neglecting is that Amazon and Facebook are run by a rare breed -- CEOs who started their companies from scratch and are performing at the very top of their field as public company leaders.

Companies that invest in this way gain market share over the long run. That's because their higher level of fixed costs enables them to lower their average costs. Growth leaders can use those lower costs to cut prices, gain more market share, and collect more cash that they can invest to lower further those average costs.

To be sure, such companies earn lower profit margins.

But they sell more – and eventually gain so much market power that they can raise prices without losing market share — thus reaping a profit bonanza.

Amazon is a great example of this idea.

It invests capital in warehouses, inventory, delivery networks, and computer systems that give it the ability to keep prices low and spread those fixed costs over a huge number of orders.

Amazon also keeps inventing new products and services that it can sell customers to increase even more the number of orders over which it can spread those fixed costs.

Oyer also noted that Amazon keeps looking for ways to get machines to do the work of people — citing its experiments with drone delivery.

For now, Amazon barely makes a profit, but investors believe it will eventually be able to raise prices and expand its margins, Mazzeo suggested.

How can this be measured -- for one thing, Amazon's cost of goods sold and payroll expenses have grown more slowly than its sales.

But Amazon’s cost of goods sold grew more slowly — by 92% to about $71.7 billion while its Sales, General, & Administrative expense as a share of total operating expenses fell from about 69% to about 61%.

AWS has clearly shown that Amazon can reap the profit benefits of investing in fixed costs to profit from market leadership.

But the full profit potential of this growth strategy has yet to reveal the cornucopia of its pleasant surprises for Amazon and Facebook investors.

I ditched corporate America in 1994 and started a management consulting and venture capital firm (http://petercohan.com). I started following stocks in 1981 when I was in grad school at MIT and started analyzing tech stocks as a guest on CNBC in 1998. I became a Forbes contr...